CATY - Cathay General Bancorp: At The Current Price It May Not Be Worth It

2023-11-11 23:48:55 ET

Summary

• Cathay General Bancorp has experienced a decline of 12% YTD and the banking crisis at the beginning of the year has not been fully resolved.
• The composition of deposits at Cathay has changed dramatically, with non-interest-bearing demand deposits decreasing and expensive time deposits increasing.
• The net interest margin has dropped by 45 basis points from last year, but is still higher than the average of peers. The net interest margin is expected to be between 3.45%-3.50% in the next quarter.

Cathay General Bancorp ( CATY ) operates as the holding company of Cathay Bank and offers various commercial banking products and services to individuals, professionals, and small and medium-sized businesses in the United States.

2023 has been a turbulent year for this bank, declining 12% YTD. The banking crisis at the beginning of the year has not yet been fully resolved and the dividend yield is much higher than the average of the past 10 years. At first glance it might seem like a good time to invest in it, but in my opinion it is more reasonable to wait for a further collapse.

Brief summary of Q3 2023

Like almost all banks, the main problem for Cathay is to keep non-interest-bearing deposits high in order to preserve the net interest margin. In the last quarter the outflow seems to have halted after months of decline, however compared to Q4 2022 - pre-SVB bankruptcy - the composition of deposits has changed dramatically.

Non-interest-bearing demand deposits have gone from being 22.50% of total deposits to the current 18.50%. In contrast, the expensive time deposits, went from being 37.90% to the current 46.90%. Their average cost in Q3 2023 was 3.91%, so it is not surprising that they are having a rather negative impact on the net interest margin. After all, compared to last year, they cost an average of 310 basis points more for Cathay.

74% of them will mature in the next 6 months, so they will have to be refinanced at probably higher rates, unless the Fed surprises everyone and decides to reduce the Fed Funds Rate in early 2024. The choice to refinance them seems rather forced since in this historical period it seems an impossible feat to attract capital without guaranteeing an adequate yield. As long as government bonds yield around 5%, customers' incentive will not be to settle for a low return on their deposits.

The net interest margin reached 3.38%, down 45 basis points from last year. This is a major drop but still keeps the net interest margin higher than the average of peers. Banks with assets between $1-$4.90 billion posted an average net interest margin of 3.11%, 27 basis points lower than Cathay.

According to management's expectations , the net interest margin is expected to be between 3.45%-3.50% in the next quarter, so the bottom probably was reached this quarter.

Finally, let's take a look at interest rate risk.

In the event of a major rise in rates, Cathay would find an improvement in profitability but a deterioration in equity. In the case of a decline, the result is reversed. Changes in equity depend mainly on the trend in unrealized losses; in fact, the latter increase as rates rise. In Cathay's case, AOCI reached $123.53 million, about 5% of equity.

Dividends

Cathay is a bank that tends to reward shareholders through both dividends and buybacks. Starting with the former, the current dividend yield is 3.89%, which is in line with recent months but higher than the average of the past 10 years (2.94%).

The dividend payout ratio is only 27%, so this implies that the dividend is sustainable in the short term. The median for the sector is 36%, so Cathay has a more conservative approach to dividend issuance. In any case, taking a look at the past, we can see that the dividend has often encountered difficult times.

After the subprime mortgage crisis, there followed years when there was no dividend, and in other years there was no growth.

If we evaluated the dividend growth of the last 10 years, the CAGR was huge, 42.28%, but if we evaluated the last 3 years it was only 3.13%. In other words, when the monetary policy was ultra-expansive, the management increased the dividend disproportionately, but at the first difficulties there was a change of direction. During the pandemic the dividend has remained stable and recently has only experienced a small increase.

In light of these considerations, I believe Cathay's dividend growth will be limited in the coming years since the macroeconomic environment is currently adverse.

After all, even the Street Estimates denote a halo of pessimism through 2025. In fact, EPS are expected to worsen both this year and next, only to get a slight rebound in late 2025. Negative as they are, these estimates may be far too optimistic since they do not take into account a potential recession in the coming years. Yield curve inversion has almost always been a predictive sign of economic slowdown in the months ahead, and I expect it will be so this time as well.

Finally, it is also good to consider the opportunity cost of investing in Cathay. By doing so we are eligible for a dividend yield of just under 4%, whose sustainability is at risk in the event of an economic slowdown. EPS is revised downward over the next few years, so the dividend is likely to remain stagnant unless the payout ratio is increased.

So, based on these assumptions, it may make more sense to buy U.S. government bonds since they yield around 5%. Not only do they have a higher yield than Cathay's dividend yield, but they are also risk-free. By buying a high duration bond there is also the potential to make a great capital gain once the Fed stops its restrictive monetary policy. At this stage, I think bonds are more interesting than dividend companies, especially if the latter are procyclical.

Potential capital gain and buyback

As already anticipated, Cathay tends to remunerate its shareholders through buybacks; in fact, about 10% of its outstanding shares have been withdrawn from the market since 2017, a large number for a bank.

In any case, buybacks have stopped in recent quarters because management does not consider the current moment appropriate to use liquidity in this way. The buyback has a negative impact on equity, and in the current uncertain time it is not the case to take avoidable risks.

Finally, in terms of capital gains, Cathay seems undervalued based on its equity.

The price/ TBV per share is 1.12x, lower than the average of 1.66x over the past 17 years. Multiplying the first figure by the current TBV per share of $31.11, results in a fair value of $51.64 per share. So Cathay is undervalued, but in my opinion not enough to take the risk of buying it in the current economic environment.

Overall, Cathay is gradually regaining the ground lost in recent quarters due to excessive distrust of the banking sector, but it is still far from being as strong as it was in Q4 2022. Time deposits are taking an increasing weight and much of it will have to be refinanced in the next 6 months. The net interest margin seems to have bottomed out, but only in the next quarter we will know for sure.

Finally, the key leading indicators signal that 2024 may not be a good year, and Cathay has performed quite poorly during those periods. The dividend yield is almost 4%, in my opinion too low when we consider that Treasury Bonds still yield close to 5%. By the way, the latter, tend to perform well especially during recessions since the Fed is forced to cut interest rates to stimulate the economy.

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